Market bets against Apple's future

By almost any measure, Apple Inc. had an awfully good start to the year. It sold $43.6 billion worth of stuff, a record for this time of year, and earned $9.5 billion. It sold 7 per cent more iPhones than a year ago and 65 per cent more iPads, and recorded 30 per cent more revenue from iTunes, software and service sales. It had $12.1 billion in cash in its accounts and $105.6 billion in liquid securities. The company said it will more than double the amount of lucre it returns to shareholders in the form of share buybacks and dividends.

These should be the best of times in Cupertino. But while things in many ways look good for Apple, they are looking considerably less so for AAPL. Shares of the widely held stock are off 43 per cent since its September high. And the reasons why teach something about business and innovation.

Apple's soaring profitability over the last decade has been driven by a series of successful new products: first the iPod, then the iPhone, then the iPad.

Each of those products has followed a cycle: brilliant innovation, followed by explosive growth in sales, paired with profit margins that make other makers of consumer technology products drool, followed by a levelling off of sales, an onslaught of new competition as rivals catch up in quality, downward pressure on margins, the end. The reason Apple is the nation's greatest corporate success story of the last decade is that as the pattern has run its course, it has always had a new bold idea on the horizon to repeat the cycle.

But the thing is, products that change the way people live and are rapidly adopted by millions don't come along every day. Even Steve Jobs, the late Apple CEO and likely the greatest innovator of his generation, arguably only really had four consumer products that revolutionary: the original Macintosh computer, the iPod, iPhone and iPad.

Almost by definition, products that could live up to the success of those predecessors are going to be hard to imagine; if it were easy to imagine them, somebody would have already made them. Apple is looking to revolutionize television, but it is no slam dunk they will succeed. They have shown less public interest in plowing money into projects far outside of their core expertise than some tech giants, in particular Google with its efforts to create driverless cars.

So Apple's stock price is essentially a minute-by-minute referendum on the ability of the company to find some big new thing that will drive profits over the coming years. At its current price of around $400 a share, investors are betting the answer is "no" -- that while Apple will still make plenty of money from iPhones, Macs and other products to come, there will be no explosive growth out of the company based on the new iThing. Its stock-price-to-earnings ratio is 9.6, meaning every $1,000 worth of Apple stock you buy gets you $104 in annual earnings power. That's the kind of number you would expect to see on a company in a declining industry, not a titan of technology. (By contrast, the same investment in Caterpillar buys you $89 in earnings, implying the market expects better earnings growth from the construction-equipment maker than it does from the iPhone maker.)

The reason Apple stock was down Wednesday despite reporting better-than-expected profits is investors view the company's decision to return more money to shareholders as a tacit acknowledgement they don't have major investment opportunities on the horizon; you only need a $100-billion hoard if you have something to spend it on, and if you don't, you may as well give it to the shareholders.

The market's pessimism about Apple's future profitability is a bet true, world-changing innovations like the ones that made the company wildly profitable in the last decade don't come around every couple of years and are more rooted in the brain of one exceptional individual rather than in the organization he created and led.

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